Big Oil's $4 billion tax break in doubt

President Obama once again calls for the subsidies to end as high gas prices erode Republican opposition.By Steve Hargreaves, senior writerApril 29, 2011: 12:29 PM ET

NEW YORK (CNNMoney) -- President Obama repeated his call Tuesday for an end to $4 billion in oil industry tax breaks as gas prices approach $4 a gallon and after a top lawmaker indicated a possible shift in Republican policy.

In a letter to congressional leaders, the president said the oil industry is profitable enough without the tax incentives and that the money should be spent on alternative energy sources and conservation.

"CEOs of the major oil companies have made it clear that high oil prices provide more than enough profit motive to invest in domestic production without special tax breaks," said Obama. "As we work together to reduce our deficits, we simply can't afford these wasteful subsidies."

This week those profits are going to be front and center. BP (BP) is expected to report earnings on Wednesday. Exxon (XOM, Fortune 500) is slated to announce its results on Thursday. Some analysts expect the company's profits to jump 50% from last year. Chevron (CVX, Fortune 500) is scheduled to make its earnings announcement on Friday.

The oil industry and many of its supporters in Congress have long argued that the tax breaks encourage domestic oil production and provide jobs for millions of Americans. Republicans in particular have resisted efforts to eliminate these tax breaks, something many Democrats have been trying to do since at least 2008.

But on Monday night, Speaker of the House John Boehner indicated he might be open to taking some of those breaks off the table.

"I don't think the big oil companies need to have the oil depletion allowances, but for small, independent oil and gas producers, if they didn't have this, there'd be even less exploration in America than there is today," Boehner said on ABC's World News Tonight. "It's certainly something we need to be looking at."

Depletion allowances let oil companies treat the oil in the ground as capital equipment, and they can write off a certain percentage for each barrel that comes out.

On Tuesday the speaker appeared to backtrack from those comments, with an aid telling CNN that "what the President has suggested so far would simply raise taxes and increase the price at the pump."

Nonetheless, Obama took the chance to pounce, saying in his letter that he was "heartened that Speaker Boehner yesterday expressed openness to eliminating these tax subsidies."

This all comes as the price of gasoline surges above $4 a gallon in many states, making it increasingly difficult politically to defend Big Oil.

As gas prices approach their record highs set in 2008 they are threatening to derail the nation's nascent economic recovery.

The tax breaks in question

The Obama administration is targeting nine tax breaks, according to a paper from the left-leaning Center for American Progress. Four account for the lion's share of the money:

Domestic manufacturing tax deduction: This is the largest single tax break, and would save over $1.7 billion a year if eliminated.

The tax deduction, passed in 2004, is designed to keep factories in the United States. Companies that manufacture here can deduct 9% of their income from operations that are attributed to domestic production.

But some question if that incentive is really appropriate for oil companies. "What are they going to do, move the oil field to the North Sea," said one staffer at the Center for American Progress said in an interview earlier this year.

No, but higher costs in the United States may make them move the drill rigs to the North Sea or some other place.

Eliminating the tax breaks "would actually discourage new energy projects and new hiring in one of the nation's most dependable job-creating industries," the American Petroleum Institute said in a statement at the time, noting the industry currently supports over 9 million jobs.

The percentage depletion allowance: This lets oil companies deduct about 15% of the money generated from a well from its taxes. Eliminating it would save about $1 billion a year.

The deduction essentially lets oil companies treat oil in the ground as capital equipment. For any industry, the value of that equipment can be written down each year.

But critics say oil in the ground is not capital equipment, but a national resource that the oil companies are simply using for their own profit.

The foreign tax credit: This provision gives companies a credit for any taxes they pay to other countries. Altering this tax credit would save about $850 million a year.

Foreign governments can collect money from oil companies through royalties -- fees for depleting their national resources -- and income taxes.

A royalty would be deducted as a cost of doing business, and would likely shave about 30% off a company's tax bill. Categorized as income tax, it is 100% deductible.

Foreign governments long ago grew wise to the U.S. tax code. To reduce costs for everyone involved and attract business, they agreed to call some royalties income taxes, allowing oil companies to take the 100% deduction on a bigger slice of their bill.

Intangible drilling costs: This lets the industry write off about $780 million a year for things like wages, fuel, repairs and hauling costs.

All industries get to write off the costs of doing business, but they must take it over the life of an investment. The oil industry gets to take the drilling credit in the first year.

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